A funny thing happened on the way to economic Armageddon: Iceland’s very desperation made conventional behavior impossible, freeing the nation to break the rules. Where everyone else bailed out the bankers and made the public pay the price, Iceland let the banks go bust and actually expanded its social safety net. Where everyone else was fixated on trying to placate international investors, Iceland imposed temporary controls on the movement of capital to give itself room to maneuver.

Iceland holds some key lessons for nations trying to survive bailouts after the island’s approach to its rescue led to a “surprisingly” strong recovery, the International Monetary Fund’s mission chief to the country said.

Iceland’s commitment to its program, a decision to push losses on to bondholders instead of taxpayers and the safeguarding of a welfare system that shielded the unemployed from penury helped propel the nation from collapse toward recovery, according to the Washington-based fund.

***

Iceland refused to protect creditors in its banks, which failed in 2008 after their debts bloated to 10 times the size of the economy.

Unlike the US and several countries in the eurozone, Iceland allowed its banking system to fail in the global economic downturn and put the burden on the industry’s creditors rather than taxpayers.

***

The rebound continues to wow officials, including International Monetary Fund chief Christine Lagarde, who recently referred to the Icelandic recovery as “impressive”. And experts continue to reiterate that European officials should look to Iceland for lessons regarding austerity measures and similar issues.

Rather than bailout the banks — Iceland could not have done so even if they wanted to — they guaranteed deposits (the way our FDIC does), and let the normal capitalistic process of failure run its course.

They are now much much better for it than the countries like the US and Ireland who did not.

Unlike other nations, including the U.S. and Ireland, which injected billions of dollars of capital into their financial institutions to keep them afloat, Iceland placed its biggest lenders in receivership. It chose not to protect creditors of the country’s banks, whose assets had ballooned to $209 billion, 11 times gross domestic product.

***

“Iceland did the right thing … creditors, not the taxpayers, shouldered the losses of banks,” says Nobel laureate Joseph Stiglitz, an economics professor at Columbia University in New York. “Ireland’s done all the wrong things, on the other hand. That’s probably the worst model.”

Ireland guaranteed all the liabilities of its banks when they ran into trouble and has been injecting capital — 46 billion euros ($64 billion) so far — to prop them up. That brought the country to the brink of ruin, forcing it to accept a rescue package from the European Union in December.

“If we’d guaranteed all the banks’ liabilities, we’d be in the same situation as Ireland,” says Arnason, whose Social Democratic Alliance was a junior coalition partner in the Haarde government.

***

“In the beginning, banks and other financial institutions in Europe were telling us, ‘Never again will we lend to you,’” Einarsdottir says. “Then it was 10 years, then 5. Now they say they might soon be ready to lend again.”

No, you've plenty of company.Krugman's writing makes little sense because his thoughts make little sense.It's not his grammar or writing style that's cumbersome.It's his thought process... has about as many holes as a Goth girl's nose.

They leave out the important part --- what "Iceland" actually did right. That was for regular folks to literally, physically chase predators-DBA-government and predators-DBA-banksters out of dodge (Iceland). If those predators were still in control, NONE of the good stuff would have happened. Therefore, the bottom line is, what Iceland did right was... to have a quickie revolution.

Yeah Iceland showed the way. The way to kill the banks and the banking system of the West owned by US and UK. Remember when Iceland did it. The UK was close to declare war to Iceland. They immediately confiscated everything in reach which was somehow connceted to Iceland.

GTerrece is somewhat bigger than Iceland. Thats why bankruuptcy has to be avoided by all means. The Germans have the fault that Greece is so dep in the debt thats why the Germans should pay the bill. But unfortunately they do not like to pay the bills of Greece.

So Greece declares bankruptcy very soon but why should they go back to Drachma. The people there like the Euro and anyhow they have no other money. The Greek government is anyhow not capable to organize something like going back to the Drachma.

So the banks go bust. But there is a solution. There are two players which always boast that their currencies are superior to the Euro because they can just print as much as they want no matter what happens to the value. These two player UK and US can now show how fast there presses can run. Full speed and overtime 24/7 that is needed to save the systemic important banks all over the world. Its their system anyhow owned by the US and UK. So the two have to take care if they want to continue with their bullshit system.

You don't get it. It was not the government or banks that "pulled an Iceland", it was the people who literally chased the politicians and banksters out of their country. Screw the predators-DBA-government and screw the predators-DBA-corporations involved in these scams. Chase them out of dodge, lock them in cages, or hand them.

THAT is what Iceland did right, and THAT is why nowhere else has or will.

The very idea that the taxpayers should somehow make private bankers whole on their losses (based on stupidity) is in itself ludicrous. The only reason it has happened here in the U.S. is the idiotic political system which makes all politicians for sale to the highest bidder. Political capital is the one investment that brings the highest return; we need to find a way to stop it and be like Icelanders. Screw the banksters.

GW- Would love to see articles like this putting up ideas for us here in Illinois. We need ideas from smart financial folks like you and your readers because our political class and media are clueless, and the real numbers for state and local government here are insurmountable. Together with other problem states we represent a multi-trillion dollar systemic risk to the economy. People like me who have been screaming about how bad it is for ten years continue to be ignored. Help!

Personally, I'ld love to hang the freakin bastards in the streets .... by their nuts! Convicted of massive fraud, thievery, corruption ..... firing squad in the street! Start with the top a-holes! Where's that freakin John Corzine ....

I'm telling you, I smell blood running in the streets .... and if th powers to be don't want to punish the miscreants, we will ..... and then we'll come after them.

Machetes, clubs and guns arent used by suburban Princesses [male and female]. The mobs will kill suits, new SUV drivers and pink people. Us and family.

The night before it blows, Sunday 5pm EST, the 1% will jump in their boats in Manhattan and head to the hideouts with mercenaries. If you or I are in the city or burbs when it blows, even guns wont allow us to flee to the boonies on Monday.

Jefferson said were done when we vote ourselves benefits and its geting to be about time. Australia here I come!

If there's any validity to the USA Today polls (not a rag I normally pay any attention to), that most Americans are disenchanged with both Romney and Obama, than there may, just may, be a sliver of hope for the American future.

With Romney we are presented with a super-Nazi; with Obama a Nazi.

Yes, I am unequivocally stating that anyone who repeatedly invokes the Espionage Act against American whistleblowers is a Nazi; anyone responsible for preemptive arrests of American activists is a Nazi; anyone who fights against due process and supports indefinite detention is a Nazi.

And on the economic front, anyone who appoints the tope three jobs offshoring specialists in America: Diana Farrell (McKinsey Global Institute, editor of Offshoring, and author of McKinsey's infamous report urging the offshoring of all jobs excepting hers), Jim Kolbe and Jeffrey Immelt (GE) is a certified Nazi; and Romney is only worse!

There is no lesser of evils when the choice is between the likable fascist, Obama, or the jackhole ultra-fascist, Romney.

Now the finest presidential candidate in my lifetime, at least since President Kennedy, is Dr. Jill Stein of the Green Party.

We are both highly fortunate and privileged she has chose to run, given the corporate-controlled media propaganda machine extant in America today.

Our last, our final chance, in this country is to elect Jill Stein in 2012!

Let us pray that not only those USA Today polls are valid, but that the American electorate finally wakes up.

The 1% are using Jill to enact a new tax on energy, paid by the middle class. She means well but Rockefeller started the environmental movement. 1% will have the Marxists fight the suburbs in order to destroy the Constitution. 1% will have destroyed any chance of middle class saving the US. We'll all be poor then. The 1%'s Marxist stooges will gladly take revenge on the 1%'s middle class stooges people. Goodbye Republic, hello Roman Empire!

iceland doesnt half 75% of the population living off the gov teet like we have in the usa. the entitles classes (unions/military/welfare) cant allow the gov or the banks to go under or they starve. we are past the point of no return.....

Iceland has a tax base of 42% of GDP and government budget is over 50% of GDP ... the US has a tax base of 22% of GDP and a government budget of 39% of GDP (both including social security). Big government is an overblown problem in the US, it is in fact a diversion ... all the effort talking about big government avoids talking about how to fix government in realistic ways.

TPTB like the ideological purity games ... you'd all rather let a complete collapse come than compromise and work together with your most obvious allies, the progressives (Kucinich's writing on Syria would have fit right in on the ZH front page).

Sadly I think you are right. Marxism works in Scandanavia cuz there isnt more losers than winners. US has a large % of residents that cant compete with the average [or above] jobholders. The % of incompetents employed by govt and on govt benefits has reached critical mass. US has so many thugs and so little morality that all it takes is a crisis to tip US into Marxism.

Marxists plan is to overload the US with debt ala Cloward, Piven, Ayles. When there is a big collapse, Latin gangs and new black panthers will sweep the suburbs and dare us to stop them. They have that rage for revenge against us.

Suburban American princesses [of both sexes] shy away from machetes, clubs and guns! They have the cities now. They will take the suburbs. They dont need rural America to control the US. They know that the cops are only after-the-fact report takers. Maybe not by places like the Empire State Bldg. But cops in the suburbs are few and far between when the thugs attack. Search news reports- its already started. They shot a girl in St. Louis for her phone.

Give credit where credit is due. Look at the crime stats. Of course not all are thugs. Even Jesse Jackson says he's scared when walking down a street in the hood and he hears footsteps behind him..

Do you invest when probabilities are 90% against you? Would you live where crime by one group against another is 10 to 1? That is now everywhere but rural America. They say if it aint fair [ house and 2 new cars and vacay twice a year for all] then burn it or tax it to oblivion.

Dont let PC mesmerize you. You haveto walk American streetes to know. What country are you in?

Marxists plan is to overload the US with debt ala Cloward, Piven, Ayles. When there is a big collapse, Latin gangs and new black panthers will sweep the suburbs and dare us to stop them. They have that rage for revenge against us.

Congratulations, you managed to write the single dumbest paragraph I've ever read.

the key reason Iceland made this decision to let the banks go under as well as the bond holders was not mentioned in the article

the Premier of Iceland decided to have a referendum of the PEOPLE - the people decided directly not the politicians not to support the banks, revalue the currency and walk away from the debts even when threatened with sanctions by the Netherlands and the UK

if Paulson et al were not the decision makers and the USA citizens made the decision in a referendum they would have tanked the banks

the USA is a control fraud - only reason we have a debt problem and a jobs problem

Iceland is not a Socialist democracy, its is currently ruled by a coalitions of Social democrats and Left green, but if you look at history you will find that the Independence party who is a right wing party has been dominating Icelandic politics.

The current goverment took over after the old Independence/Social democrat govt was run out of parliament by a large group of very angry people.

Icelanders have always supported capitalism, and it worked out quite well for a while despite all the corruption.

At some point something in the system broke, capitalism went into hyper drive, a origy of privatization and deregulation, and when it all started to fall apart the idiots tried to create a fusion of this fucked up capitalism and socialism. Privatize the good times and socialize the bad.

Iceland is a republic based on parliamentarism based on democratic elections, where the biggest voter block can be described as "social democrats" and where popular referenda can be set up per act of parliament.

Damn, the more I read this kind of comments based on the fact that the two US parties are just called like two principles of rule the more I get the impression that this is really a big civic education issue.

Am I the only one who remembers the pictures of mobs of Icelandic voters surrounding the house of parliament, literally with torches and pitchforks, threatening to kill the politicians if they bailed out the banks?

Krugman takes positions on all sides of the fence. He was a staunch bailout defender, loved TARP, considers default on bank debt unthinkable, etc. He usually attributes Iceland's success to currency devaluation. This is what makes him an archtypical economist. Which Krugman was right?

Bof of'em, depending on whether or not one is .01% or 99.99%er. Gotta go watch Idol after I go get me some beer and pretzels on my govment cc or I could just call for a delivery on my govment cell phone. Decisions, Decisions. Circus anyone? It worked for Caesar.

The one true law that applies to everyone EXCEPT the banks is survival of the fittest. Natural law.

My business was crushed by the recent unpleasantness and assets were transfered back to bank balance sheets. So they took my shit, and bailout money, and were given fantasy accounting rules.

Someone please explain to me how that is a naturally functioning economy. I fully accept the fact that my business was based on some bad assumptions, it sufered, and has contracted significantly. As it should have. I'm a big boy and can take it, but these little bitch banks play like baby girls and whine the minute they feel any pain.

The key to understanding these bailouts is remembering that they help the bondholders, shareholders and employees of the banks to the detriment of everyone else.

These are the steps of a bank bailout:

A bank's poor lending and investment decisions lead it to go broke.

None of the investors in the market want to be the last man standing on a sinking ship, so a sell-off ensues.

If the sell-off leads to a market panic, then people will get nervous and demand that the government "do something."

The government intervenes with loans, extra capital and liquidity injections. These are all euphemisms for giving the banks taxpayer money.

Once you start intervention, you cannot stop. Hence, the intervention continues indefinitely into the future with permanently low interest rates and cheap, no-questions-asked loans becoming part of life in the banking industry.

The banks become zombies, neither vibrant, ongoing concerns nor failing entities. These zombie banks lead to a zombie economy that generally remains stagnant for years to come à la Japan.

Contrast this scenario with what happened in Iceland. These are the steps to letting the banks fail:

A bank's poor lending and investment decisions lead it to go broke.

None of the investors in the market want to be the last man standing on a sinking ship, so a sell-off ensues.

The government decides to let the banks fail.

The country's currency drops like a stone, markets panic, multiple institutions fail and the country enters a depression.

A cheaper currency combined with the effects of getting the bad debt out of the system begin the cycle of economic growth again.

New banks step in to fill the role of the failed banks.

The first scenario is what is happening in Japan (for years), the US and Europe and the second is the current situation in Iceland. Which do you prefer?